A perspective on current oil economics

Oil economics is central to the fortunes of the Indian economy. Oil prices work as a joker in the pack, which can boost or dampen the growing apple cart of the economy. Crude market is waiting for a firm direction and seems to be consolidating around $60 a barrel. Fuel forming a large share of India’s imports and India aspiring to grow exponentially implies that Indian economy would continue to remain vulnerable to changes in crude oil prices.

Though the worry on high oil prices seems to have subsided now but under the apparent calm, a lot is brewing, which has been overlooked in the latest credit policy. A new dimension to oil economics has emerged ie the USA unleashing a revolution by way of its shale oil and gas boom, which is coming to the aid of Indian economy.

India in global oil economy
Fueled by policy reforms and rebound in credit, India’s economy is forecast to expand by 7.5 % during FY20. It is perceived as the most dynamic and fastest growing economy and at the forefront of technology and social innovation. Also poised to become the third-largest consumer market (nearly $6 trn by 2030), next to the US and China.

A number of black swan events have been experienced in recent times, the most prominent being ‘turbulent oil prices’, impacting fortunes of emerging markets. Overnight the oil environment changed from a period of persistently high oil prices to a period of low oil prices.

Global slowdown, particularly China’s slowdown, has been dampening oil prices. On top inter-country rivalries have started accentuating the mixing of oil economics with politics, thereby causing heightened fluctuations in oil prices.

Oil economics’ significance
India imports more than 80% of its oil requirements and constitutes as much as 14% of global demand growth. India will be surpassing China in oil demand growth this year itself.

Recently, a sharp rally in crude oil prices led to renewed concerns about India’s twin deficits (fiscal and current account) resulting in a massive fall in the value of the rupee. But soon luckily oil became cheap which has enabled the country to meet the fiscal deficit target (3.3%-3.4%) this year.

Indian economy is diverse and complex. It has begun to realise fruits of its vast potential. But still the journey is long and the path of Indian oil economics in the country is strewn with distortions & incongruities —

• High taxation burden on oil persists despite GST implementation as it is main source of revenue for the government. Taxation is also not uniform across States. Petrol and diesel prices in Delhi are the cheapest among all metropolitan cities. Besides, Delhi government taxes petrol and diesel at an ad valorem rate while the Uttar Pradesh and Haryana have adopted a fixed sales tax structure, again leading to divergent prices.

• Variety of petro-subsidies prevail, which are not only huge but also distortionary, some implicit while others explicit. India is staring at a fuel subsidy burden between Rs 34,000 crore — Rs 53,000 crore in 2018-19, the highest since fiscal year 2014-15

Current scene
Crude prices have been fluctuating, rising up to $86, then reducing to $58. Recently, crude oil prices started rising again sending a signal that it’s time to accelerate shift to alternate fuels.

Oil volatility is due to various reasons like OPEC cut being different from its compliance, the deepening of the Venezuela crisis due to the US sanctions on its oil industry, uncertainty regarding outcome of the US sanctions on Iran, the evolving dynamics of America-China trade and the exchange rate and the US wooing India with cheaper oil in view of imports slackening from Iran.

Interim Budget and oil
There has been no big-bang announcements for the energy sector. Petroleum subsidy is hiked to Rs 37,478 crore for FY20. Subsidy provisions may reignite interest in ONGC & OIL. Options available to the government will be to either defer the subsidy payments to oil companies to the next fiscal, with appropriation from FY20 budgetary allocation or ask the downstream or upstream companies to bear part of the subsidy.

Importantly, the impending changes in bidding framework for new Oil & Gas blocks have been announced in order to boost domestic production. However, Rs 93,639 crore capital outlay proposed for oil and gas companies for FY20 would be the lowest spending done in past four years. Ironically, the decline in spending comes at a time when the government has increased its focus on ramping up domestic oil output to cut costly oil imports.

In sum
Recent decline in oil prices has made India an attractive investment destination again. But the fundamental weaknesses in India’s macroeconomic balance sheet cannot be overlooked. Oil prices in future will be all about the economies — US shale production, OPEC & its allies’ stance, US sanctions on Iran and threat of sanctions on Venezuela. For India, it has become critical to manage oil price risks.

GST is expected to correct most of the distortions when oil products in entirety will get covered. But by when is uncertain. Recently, GST Council chief said that this will happen only when revenues position becomes comfortable. Even if the Centre wants, it cannot bring oil products under the GST until the state governments agree.

States at present are apprehensive about their own income. As long as there is no two-thirds majority in the GST Council, this cannot be accomplished. The Interim Budget has not given any clue to this except referring to oil exploration initiatives.

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